Learning to live without Freddie and Fannie
March 30, 2014
To paraphrase the great Don McClain, "The two firms we admired the most, will catch the last train for the Coast."
Sometime in the relatively near future, Fannie Mae and Freddie Mac will almost certainly be no more. In Congress both the House and Senate are coming up with bills to phase the mortgage conduit giants out of business.
The consensus is that the federal government, i.e. the taxpayers, shouldn't provide an unlimited guarantee for millions of mortgages generated by the U.S. economy.
The Senate bill would eliminate the government sponsored enterprises (GSE), but make federal insurance, similar to deposit insurance, available for purchase to enhance the quality of mortgage backed securities. The House, which doesn't yet have a clear cut bill in committee, would rather see the government out of the mortgage guaranty business entirely.
It should be noted that both companies are back to making a bundle, and presumably doing it with little risk. They've already paid $185 billion back to the U.S. Treasury to cover the taxpayers loss when they were taken over in 2008. This certainly validates their viability; whether they're needed is another question.
Fannie and Freddie certainly weren't responsible for the economic crisis. Mortgage backed securities have been around for close to 75 years, guaranteed and not. Those that were backed by the U.S. Treasury never ever required a massive bailout until the crash of 2008. That's because the loans that backed them were sound, and borrowers paid them back.
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The problem of the GSEs is simply stated by the old cyber mantra "Garbage in, garbage out." Everybody was making sub-prime loans that literally weren't worth the paper they were written on, so Fannie and Freddie joined the crowd. It's like all of the other kids were jumping off a cliff and making a ton of money on the way down, so the prissy white shoe kids from the right side of the tracks followed suit. It was high stakes economic peer pressure. Fannie and Freddie didn't want to look like class nerds, so they joined hands and jumped right in.
Everybody was making bad loans, and everybody was buying bad loans. Some lenders, like Bank of America and Wells Fargo, survived, but lost billions in the process. Others, like Bear Stearns, WaMu and Countrywide, didn't.
How vital are Fannie and Freddie to the housing industry, and the national (read also world) economy in the 21st century? Maybe not much, although home builders, Realtors, and mortgage lenders would differ. Their time may have passed, like Sears, once bigger than Chris Christie, now just big empty stores in the midst of empty parking lots.
Mortgage backed securities as an investment vehicle were based on common sense and strong underlying collateral: homes. From their inception in the '40s with the creation of Ginnie Mae to provide a conduit for VA loans, strict, sound underwriting guidelines ensured that good loans made good securities. Fannie Mae expanded the concept, covering all government insured loans, with Freddie Mac coming along in the '70s to provide the same service for conventional loans, with either a relatively low loan to value ratio or with private mortgage insurance for the higher ratios.
It worked just fine. Nobody back then could conceive that lenders would actually make 100 percent loans to people who didn't have to show their income. But the lenders did, and the rest is history.
Today, the underwriting guidelines that everybody thought were carved in stone back in 1979 are mandated by statute and regulation. It's now illegal to be stupid in making a home loan, so the loans are going to be of a pretty high quality, and when they're securitized, that instrument will be virtually blue chip.
Investors may like the paper to have Federal backing, but they'll probably buy the securities anyway, because they'll likely have a top rating. Probably, in some instances, they could be enhanced by private insurance, which would be possible because the risk of massive default would be relatively low.
Housing, the U.S. economy and the world markets may find they all can get along very nicely without the GSEs, and Uncle Sam doesn't have to stand ready to pick up the tab.
At least until we all figure out how to get around the laws against making dumb loans, and jump off the next cliff.
Pat Dalrymple is a western Colorado native and has spent almost 50 years in mortgage lending and banking in the Roaring Fork Valley. He'll be happy to answer your questions or hear your comments. His e-mail is email@example.com.